What is the difference between tax evasion and avoidance?

You have probably heard advertisements claiming that you pay too much money in taxes and advertising services to help you from doing that. While it may seem perfectly reasonable that your own lack of extensive understanding of tax law may lead to an occasional overpayment, you also may view such services with a good degree of scrutiny. Still, the potential promise of lowering your tax liability can be difficult to pass up.

Yet are such services legal? The last thing you want to do is come under scrutiny for not paying taxes. Thus, they key to understanding which methods of lessening a tax burden are legal requires an understanding of the differences between tax evasion and tax avoidance.

Be wary of claims advising against reporting income

Some of the aforementioned services may state that you need not report all of your income. They typically include income from the underground economy in such claims. The Internal Revenue Service defines “underground economy” as legitimate payment and compensation for services not managed through typical business channels. This can include income gained through:

  • Private sales
  • Contracted work
  • Personal services

You may hear that such income is not subject to tax (and that do not need to report it to the IRS). Yet any instance where you purposely omit disclosures of income are examples of unlawful tax evasion.

Defining “tax avoidance”

At the same time, there are strategies in place that allow you to limit your tax liability. These include taking advantage or credits or deductions that you may qualify for, or structuring financial accounts in order to defer tax payments to a later date. Not only are such strategies perfectly legal, but they are also often encouraged by federal and state tax authorities.